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Contrarian Ideas: Undervalued Banking Stocks With Rising Earnings

Do you think the market is underestimating these names?

Thomson Reuters recently reported that third-quarter average profit estimates for Goldman Sachs Group (GS) have been slashed more than 18% over the last month to $2.28 per share. What's more, full year estimates have dropped 8% and 3% for 2011 and 2012, respectively.

Goldman's not alone. Other big banking firms have taken a hit too, such as Bank of America (BAC), whose average forecasts fell 9%, while Morgan Stanley's (MS) fell 4%.

"Goldman has fallen particularly hard because it has a greater dependence on traditional investment banking businesses like buying and selling securities, underwriting stock and bond offerings, and advising on mergers," reports Reuters.

The recent market volatility and general uncertainty do not sit well with analysts. "Even fans of the stock have gotten more cautious about how much it might rise. "The median price target for Goldman is $155, down from $170 a month ago and $198 three months ago."

Goldman Sachs hit a new 52-week low on Monday at $99.80 but had already rebounded by Tuesday's closing to $104.09 per share.

So which banks are bucking the trend? Here is a list of banking stocks that have recently seen an increase in their earnings projections.

What's more, all of these banking stocks are undervalued, as measured by the Graham Equation (developed by Benjamin Graham, a.k.a. the godfather of value investing).

Graham's principles of value investing serve as the basis for the Graham Number, or the maximum price an investor should pay for a stock. It's derived using only two data points: current earnings per share and current book value per share.

The Graham Number = Fair Value Of A Stock = Square Root of (22.5) x (Earnings Per Share) x (Book Value Per Share)

For Graham, the price-to-earnings (P/EPS) ratio should be no more than 15 and price-to-book value (P/BVPS) ratio should never exceed 1.5.

As a general rule, Graham insisted that the product of the two shouldn't be more than 22.5. In other words, (P/EPS of 15) x (P/BVPS of 1.5) = 22.5.

Take the square root of both sides, and you get the equation for the Graham Number.

Fair Value PricePrice = Square Root of (22.5 x EPS x BVPS)

It's a useful way to help determine a stock's relative value -- but it's no substitute for your own research. Use it as a starting point for further analysis.

The following banks are bucking the trend, and seeing their earnings projections rise. What's more, they all appear undervalued -- do you think the market is underestimating these names? (Click here to access free, interactive tools to analyze these ideas.)

1. Northern Trust(Nasdaq: NTRS): Provides investment management, asset and fund administration, banking solutions, and fiduciary services for corporations, institutions, and affluent individuals worldwide. The EPS estimate for the company's current year increased from 2.65 to 2.69 over the last 30 days, an increase of 1.51%. This increase came during a time when the stock price changed by -7.23% (from 37.63 to 34.91 over the last 30 days). Diluted TTM earnings per share at 2.52, and a MRQ book value per share value at 29.15, implies a Graham Number fair value = sqrt(22.5*2.52*29.15) = $40.65. Based on the stock's price at $34.95, this implies a potential upside of 16.32% from current levels.

2. East West Bancorp(Nasdaq: EWBC): Operates as the holding company for East West Bank, which provides a range of personal and commercial banking services to small and medium-sized businesses, business executives, professionals, and other individuals in California. The EPS estimate for the company's current year increased from 1.54 to 1.55 over the last 30 days, an increase of 0.65%. This increase came during a time when the stock price changed by -6.23% (from 16.54 to 15.51 over the last 30 days). Diluted TTM earnings per share at 1.24, and a MRQ book value per share value at 14.63, implies a Graham Number fair value = sqrt(22.5*1.24*14.63) = $20.20. Based on the stock's price at $15.53, this implies a potential upside of 30.09% from current levels.

3. SVB Financial Group(Nasdaq: SIVB): Operates as the bank and financial holding company that provides commercial banking and financial products and services. The EPS estimate for the company's current year increased from 3.23 to 3.3 over the last 30 days, an increase of 2.17%. This increase came during a time when the stock price changed by -10.15% (from 46.7 to 41.96 over the last 30 days). Diluted TTM earnings per share at 3.58, and a MRQ book value per share value at 33.31, implies a Graham Number fair value = sqrt(22.5*3.58*33.31) = $51.80. Based on the stock's price at $41.97, this implies a potential upside of 23.42% from current levels.

4. National Penn Bancshares(Nasdaq: NPBC): Operates as the bank holding company for National Penn Bank that provides commercial banking products and services to residents and businesses primarily in eastern and central Pennsylvania. The EPS estimate for the company's current year increased from 0.51 to 0.53 over the last 30 days, an increase of 3.92%. This increase came during a time when the stock price changed by -2.6% (from 6.91 to 6.73 over the last 30 days). Diluted TTM earnings per share at 0.4, and a MRQ book value per share value at 7.47, implies a Graham Number fair value = sqrt(22.5*0.4*7.47) = $8.20. Based on the stock's price at $6.78, this implies a potential upside of 20.93% from current levels.

5. Bank of the Ozarks(Nasdaq: OZRK): Operates as the bank holding company for Bank of the Ozarks that provides a range of retail and commercial banking services. The EPS estimate for the company's current year increased from 2.73 to 2.74 over the last 30 days, an increase of 0.37%. This increase came during a time when the stock price changed by -9.62% (from 23.28 to 21.04 over the last 30 days). Diluted TTM earnings per share at 2.97, and a MRQ book value per share value at 11.27, implies a Graham Number fair value = sqrt(22.5*2.97*11.27) = $27.44. Based on the stock's price at $20.88, this implies a potential upside of 31.43% from current levels.

6. City Holding Co.(Nasdaq: CHCO): Operates as the bank holding company for City National Bank of West Virginia that offers community banking services to consumers and local businesses. The EPS estimate for the company's current year increased from 2.48 to 2.56 over the last 30 days, an increase of 3.23%. This increase came during a time when the stock price changed by -9.38% (from 30.71 to 27.83 over the last 30 days). Diluted TTM earnings per share at 2.47, and a MRQ book value per share value at 20.58, implies a Graham Number fair value = sqrt(22.5*2.47*20.58) = $33.82. Based on the stock's price at $27.7, this implies a potential upside of 22.09% from current levels.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.

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Kapitall's Becca Lipman and Eben Esterhuizen do not own any of the shares mentioned above. Data sourced from Fidelity.